6/24/2008 @ 9:35AM

A More Refined Lukoil

With all the drama in the Russian oil and gas sector, you can’t blame Lukoil, Russia’s largest non-state controlled oil producer, for looking at growth opportunities elsewhere.

Lukoil announced Tuesday that it was paying 1.3 billion euros ($2.0 billion), for a 49.0% stake in a joint venture with Italian oil refiner and distributor ERG. The joint venture would operate ERG’s ISAB refinery in Priolo, Sicily, with an annual refining capacity of 16 million tons of oil.

Lukoil
was down 0.9%, or 85 cents, at $98.50, in Tuesday afternoon trading in Moscow.

This is a significant deal for Lukoil, which has been trying to build up its refining capacity outside Russia, said Xavier Grunauer, an analyst at Nomura in London.

Lukoil has already bought refining assets in Bulgaria, Romania, and the Ukraine, and has been looking at assets elsewhere in central and eastern Europe, including in Gdansk in Poland, and Mazeikiu Nafta, a refining plant in Lithuania. The ERG deal gives Lukoil its first refining opportunity in Western Europe.

The refinery will focus on diesel and kerosene, which according to Grunaeur, was a positive for Lukoil, given the increasing use of diesel in Europe for transportation. The location of the plant, in Sicily, is also a bonus as it is within easy reach of the Black Sea, the route through which much of Russia’s oil enters Europe.

“They want to buy assets that they can vertically integrate with into their operations,” said Grunauer. “This deal makes the logistics of vertical integration that much easier.”

In April Lukoil, which is Russia’s second largest oil producer, reported a 27.1% rise in net profits, on higher prices for its crude oil and refined products, despite a 14.3% increase in taxes.

Russia’s sky high taxes for oil and gas exports has been a headache for companies like BP, though less of a problem for the likes of Lukoil, which concentrates on exporting refined products. However, with few opportunities to expand refining within Russia, a market dominated by Gazprom and Rosneft, Lukoil has had little choice but to look for further opportunities abroad.